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The USDA Hedge: Put a Floor Beneath your Prices

Through the Risk Management Agency’s (RMA) price-protection programs, growers like Ken Gerber set a floor for corn, soybeans and wheat and are opening the door for greater marketing opportunities.

USDA’s RMA revenue-assurance and crop-revenue coverage insurance packages have been combined. But growers can still cover up to 85% of their estimated yield and work off a guaranteed price, providing more comfort in forward contracts, futures or options to take advantage of volatile swings in price. It’s a USDA hedge.

Like homeowners insurance, or truck or crop hail policies, there are high premiums, easily $30-50/acre or more. However, to protect up to 85% of your yield and price, it’s risk management that can sometimes save the farm, says Gerber, a Sabina, OH, grower and RMA licensed insurance agent.

Gerber still grows corn and beans, but reduced his acres when he entered his 60s. However, he’s close to the turn row of many southwestern Ohio growers who trust his insurance program expertise and marketing savvy.

“Our area had a lot of hail damage on late-planted beans,” he says. “Some lost as much as half of their crop. They’re glad they were insured.”

RMA coverage can be a strong price cushion for growers, says Darrell Good, University of Illinois Extension grain marketing economist. But don’t jump into an insurance program without analyzing your situation. “If you know you have a floor price under your revenue, it gives you more confidence in forward pricing,” he says “But don’t do it blindly; only do that if the market offers a better return than the insurance.”

Through RMA, growers can select coverage based on 65%, 70%, 75%, 80% and 85% of their production. They can insure based on individual farm units, or combine them into enterprise units. That usually equates to a lower policy price because policy risk is spread over more acres.

“There are two components of a price premium,” says Gerber, describing Corn Belt RMA programs. “The first is the February price-discovery period for corn and soybeans. It’s the average CBOT price for November soybeans and December corn for February. The second is a computer-generated measure of market volatility.

“The premium can change until the sales closing date of March 15 in the Midwest. So the actual premium price won’t be known until final CBOT prices and volatility measures are completed.”

Gerber says some contend that the enterprise unit discount won’t be as great for 2011. “But in situations like we’ve seen, where we have a big spread in yields, growers might still look at the cost of enterprise units, instead of individual units,” he says.

Price volatility vs. policy

Price volatility makes it impossible to know the price if and when a policy goes into effect. “We won’t know the prices until they are set the end of February,” says Good. Even the best ag economists and analysts won’t make tight price predictions. But this example uses a $5/bu. spring price for an Ohio farmer. His average yield is 170 bu./acre and he selects the 85% coverage rate.

“That will provide a minimum of $731 coverage with a revenue protection (RP) policy (170 bu. x 85% = 146.2 bu. x $5/bu.),” says Gerber. “The preliminary cost is $58.27/acre each for individual units. However, that cost is reduced to $31.68/acre if he requests enterprise units, which combine two or more individual units (in a county for which he buys insurance).”

Since the grower is guaranteed 146.2 bu. at $5/bu., he’s free to market those bushels on a cash contract (or other sale). “If he prices 146.2 bu./acre on the local market, he’s guaranteed the revenue from the policy to pay for those bushels if his yields are reduced below the 146.2 guaranteed,” says Gerber. “If he raises his average of 170 bu. he’ll have the 146.2 bu. available to meet his sales contract and have an additional 23.8 bu. to sell.”

If it’s a bad production year and he raises 120 bu./acre, he’ll only have 120 bu. available to meet his sales contract. But the RP payment for 146 bu. would enable him to make up the difference. If production is above the 146 bu., then he’ll have additional bushels to sell to add to the guaranteed $731.

Since a grower is guaranteed 46.75 bu./acre of soybeans at $11/bu., he’s free to market those bushels. “If he prices 46.75 bu./acre on the local market, he’s guaranteed the revenue from the policy to pay for those bushels if his yields are reduced below the 46.75 bu. guarantee.

If yields make only 40 bu., the RP policy will provide payment for the additional 6.75 bu. needed to fulfill his contracted beans. If production is above the 46.75 bu., then he’ll have additional bushels to sell and add to the guaranteed $514 in the RP policy.

Gerber notes that the $514/acre soybean RP or $731 corn RP will rise if the harvest price (the average CBOT price of November soybeans or December corn in the month of October) is higher than the February planting price.

The RP insurance will provide price protection for soybeans and corn if market prices fall this year after the strong rally prices have experienced. So insured growers will have the “hedge” in place.

Gerber adds that marketing over and above RP coverage certainly enables producers to enhance their profit capabilities, depending on their individual farm situations. Gerber himself has charted 100 years of corn and bean prices to identify dominant market cycles.

“Remarkably, prices have repeated similar cycles for decades,” he says, adding that those predictive cycles of high prices are what he bases his marketing on and insurance customer advice on.

Good says that with the price rallies seen in the fall, he has encouraged growers to get some of their 2011 crop forward priced. “We suggest that even though they hadn’t seen insurance prices, we’ve seen opportunities to marketing some of 2011 production,” he says. “They may not get too aggressive (because of price volatility) but there have been some pretty good prices.”

The cost of insurance is similar to what a grower may spend on a futures options program, Good says. “But they are very different products,” he adds. “With options, you can’t protect your yield. And with the insurance, you can’t protect 100% of your price.”

He adds that in Illinois, growers are recommended to use the full 85% RP provision. “It’s very rare that the lower coverage levels ever pay out,” he says.